Read time: 5 minutes, 45 seconds

Hey, Crypto Tax Pros!

Welcome to another edition of Chain Reactions, where we analyze only the most relevant developments in cryptocurrency taxation and regulation.

This week, we’re covering:

🔍 IRS playing catch-up: TIGTA report reveals crypto tax enforcement gaps
📊 Ethereum ETFs launch with a bang, generating over $1B in first-day trading
🤖 Leveraging AI to future-proof your crypto tax practice (stay ahead of the curve!)

Let’s dive in!

IRS Playing Catch-Up on Crypto Tax Enforcement: A Wake-Up Call for Tax Pros

The crypto world moves at lightning speed, but the IRS? Not so much.

A recent report from the Treasury Inspector General for Tax Administration (TIGTA) reveals just how far behind the IRS has fallen in enforcing crypto tax compliance. But buckle up, because change is coming – and fast.

TIGTA’s audit paints a clear picture: the IRS was caught flat-footed by crypto’s explosive growth. From April 2020 to July 2023, the number of cryptocurrencies skyrocketed from 5,000 to over 26,000 (and likely even more from 2023-2024). That’s a 420% increase in just over three years, leaving the IRS scrambling to keep up.

The Top 8 Takeaways From the TIGTA's Report (for Tax Pros and Crypto Investors)

1. Criminal Investigations Ramp Up, Civil Exams Lag

Here’s a number that should raise eyebrows: 390 criminal investigations involving virtual currencies from 2018-2023.

The IRS is clearly taking crypto-related crime seriously. However, civil examinations are still playing catch-up. This imbalance suggests that while the IRS is cracking down on major offenses, they’re still developing strategies for broader compliance enforcement.

2. Civil Examinations: “Indirect and Negligible” (For Now)

The TIGTA report doesn’t mince words, describing civil examinations related to crypto as “indirect and negligible.” Out of over 365,000 tax examinations conducted since 2020, only 1,144 (a mere 0.31%) included a digital asset component. That’s a drop in the ocean considering the millions of Americans dabbling in crypto. But don’t get too comfortable – the IRS plans to change this, and change it fast.

3. Underutilized Form 1040 Crypto Question

Remember that new question about virtual currency transactions on Form 1040? Turns out, the IRS hasn’t been fully leveraging this data. This is a missed opportunity for the agency, but it’s also a warning sign for taxpayers and practitioners. Just because they haven’t used this information effectively in the past doesn’t mean they won’t in the future.

4. Explosive Growth in Self-Reported Crypto Ownership

The numbers don’t lie, and they’re staggering:

12.6 million taxpayers self-reported as crypto owners from Tax Years 2019-2022
A mind-boggling 649% increase in annual self-reporting from Tax Years 2019-2021
Even with a slight dip in 2022, the 2.7 million reported owners still represent a 202% increase from 2019

These figures underscore the massive adoption of cryptocurrencies and the urgent need for tax professionals to get up to speed on crypto taxation.

5. Form 1040 Crypto Question: A New Risk Assessment Tool

The seemingly innocuous crypto question on Form 1040 is more impactful than many realize:

Answering “Yes” automatically flags a taxpayer for higher compliance risk
A false “No” answer, if crypto transactions are later discovered, raises serious red flags
However, limited third-party reporting has hindered the IRS’s ability to follow up effectively – but this is changing

For tax practitioners, this means we need to be extra diligent in verifying our clients' crypto activities and ensuring accurate reporting.

6. IRS Invests Heavily in Blockchain Analysis Tools

Here’s a wake-up call: The Office of Fraud Enforcement (OFE) has acquired and issued over 600 licenses for blockchain analysis tools to IRS employees. This significant investment signals the agency’s commitment to understanding and tracking crypto transactions. Tax pros need to be prepared for a future where the IRS has much greater visibility into blockchain activity.

7. Form 1099-DA: A Game-Changer for Compliance The upcoming Form 1099-DA is set to revolutionize crypto tax reporting. By providing detailed transaction data directly from exchanges, this form will significantly improve the IRS’s ability to verify reported crypto income. For tax practitioners, this means we’ll need to be prepared to reconcile this new information with our clients’ records.

8. A New Compliance Strategic Plan Is Coming The IRS isn’t just adding tools – they’re developing a comprehensive Compliance Strategic Plan that includes the use of Form 1099-DA data, improved case identification, and more targeted selection of digital asset cases. This holistic approach suggests a future where crypto tax enforcement is more systematic and data-driven.

The Bottom Line

The era of crypto as the “Wild West” of taxation is coming to an end.

The IRS may have been slow out of the gate, but they’re making up for lost time – and they’re coming with a vengeance. As tax professionals, we have a critical role to play in helping our clients navigate this new landscape.

Are you ready for the new era of crypto tax enforcement? It’s time to level up your crypto tax game. Stay informed, stay compliant, and be prepared for increased scrutiny. The future of tax practice is here, and it’s digital.

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Crypto Tax Pro Tip Of The Week

Here’s my favorite tip about future-proofing your crypto tax practice of the week.

It’s from my recent LinkedIn post, and this completely changed the way I thought about leveraging AI in tax practice.

Here’s a quick breakdown:

Step 1: Automate the mundane. Use AI to extract data from client documents, organize source materials, and standardize work papers. This frees up your time for high-value tasks like strategic planning and complex analysis.
Step 2: Supercharge your research. Implement AI-powered tools that integrate tax research into your workflow, provide real-time regulatory updates, and draft comprehensive analytical reports. This allows you to deliver faster, more accurate advice to your crypto clients.
Step 3: Elevate client relationships. Leverage AI to generate personalized client communications, explain complex crypto tax situations in simple terms, and identify proactive advisory opportunities. This transforms your role from a number-cruncher to a trusted advisor in the crypto space.

Hope this helps!

Curated Crypto News

Want to stay on the cutting edge?

Here's what else is happening in crypto tax, policy, and markets that you should know about:

Want to stay on the cutting edge?

Here's what else is happening in crypto you should know about:

🟣 Spot Ethereum ETFs generate over $1 billion in trading volume on first day: According to The Block, spot Ethereum ETFs saw over $1.019 billion in cumulative trading volume on their first day of trading. This is a big deal because it demonstrates strong investor interest in Ethereum and provides easier access to the second-largest cryptocurrency for institutional and retail investors alike. Personally, we think this means we’ll see increased mainstream adoption of Ethereum, potentially leading to more stability in its price and greater integration of Ethereum-based technologies in traditional finance.

⛔️ Coinbase Fined $4.5 Million Over ‘High Risk’ Customers: According to PYMNTS, Coinbase has been fined $4.5 million by the UK’s Financial Conduct Authority (FCA) for serving “high-risk” customers. This is a big deal because it highlights the ongoing regulatory challenges faced by major crypto exchanges and the increasing scrutiny on anti-money laundering (AML) practices in the crypto industry. Personally, we think this means we’ll see crypto exchanges implementing even stricter KYC and AML procedures, potentially making it more challenging for some clients to trade but ultimately leading to greater legitimacy for the industry.

🇮🇳 India Keeps Controversial Crypto Tax Rules Unchanged: According to CoinDesk, India’s Finance Minister Nirmala Sitharaman kept crypto tax rules unchanged in the nation’s budget for 2024-2025. This is a big deal because it maintains the controversial 1% tax-deducted-at-source (TDS) policy on crypto transactions and the flat 30% tax rate on gains. Personally, we think this means India will continue to face challenges in becoming a global crypto hub, potentially driving innovation and talent to more crypto-friendly jurisdictions.